Will Reid Tax the Rich?

The Senate majority leader develops a case of House envy.

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Senate Majority Leader Harry Reid

Senate Majority Leader Harry Reid is reportedly reconsidering tax options for health care reform. According to the Associated Press, Reid is thinking about raising the part of the payroll tax that pays for Medicare on families whose incomes exceed $250,000, the magic number below which President Obama has promised not to raise taxes. According to Bloomberg, Reid is also considering an alternative proposal that, rather than raise the Medicare tax, would apply it to investment income (currently exempt) for families earning more than $250,000.

Apparently Reid has woken up to the fact that the Senate finance committee’s excise tax on so-called “Cadillac” health insurance plans (i.e., family plans worth more than $21,000) has a couple of serious drawbacks. These should be familiar to regular readers of this column:

● It raises only $201 billion over 10 years. That’s less than half the $460 billion that the House bill would raise through a 5.4 percent surtax on incomes above $500,000 for individuals and $1 million for families.

● The finance committee—at the prodding of Sen. Jay Rockefeller, D-W.Va.—acknowledged that many people have expensive health insurance not because they’re pampered by their bosses but because their jobs put them at higher risk of physical injury. Consequently, it raised the threshold for the untaxed portion of these people’s plans by $5,000. But the committee was pretty stingy in defining what these high-risk professions were. The threshold was raised for law enforcement, firefighting, rescue work, ambulance services, construction, mining, agriculture, forestry, and fishing. It was not raised for anyone who works in heavy manufacturing. If this tax is to be maintained in the final bill, it will have to be whittled down further. According to the Dow Jones newswire, Reid has already raised the family threshold by $2,000 for everybody.

Policy wonks tout the Cadillac-plan excise tax—which taxes every dollar above the designated value ($21,000 under the finance committee bill, $23,000 under Reid) at a hefty 40 percent—mainly as measure to reduce medical spending. The thinking goes that since insurers really won’t want to pay that 40 percent tax (or pass it along to their customers), they’ll work very hard to keep their policies below the threshold. But to whatever extent that proves true, the tax’s value as a revenue-raiser will be diminished. If all insurerskeep the value of their policies below the threshold, the tax will raise no money at all.

And so it’s back to the drawing board. The two Medicare taxes under consideration are a bit more progressive than the Cadillac-plan excise tax. The current Medicare tax is 2.9 percent, of which half is paid by the employer and half by the employee. It is therefore not progressive at all—rich and poor pay the same percentage—though not outright regressive, as is the Social Security part of the payroll tax, which stops at incomes above $106,800. * It isn’t known how high Reid is considering raising the Medicare tax, but Citizens for Tax Justice, a labor-affiliated nonprofit, has calculated that raising the employee half from 1.45 percent to 2.5 percent for families earning more than $250,000 would raise $7.2 billion in 2012, the year the tax would likely take effect.

The second tax under consideration would keep the Medicare tax at 1.45 percent for employers and employees but would subject investment income to the tax for families earning more than $250,000. According to Bloomberg, White House Budget Director Peter Orszag says this proposal is the one that’s “in play.” One likely reason is that it’s a little harder for opponents to peg it as a tax increase because it isn’t a rate increase. Another likely reason is that it raises a lot more money: $19 billion in 2012, according to Citizens for Tax Justice, and $160 billion through 2019.

Raising or (ahem) extending the Medicare tax is not without peril. With many senior citizens already up in arms about health reform’s proposed cuts to the Medicare program, adding a tax-rate increase that has the word Medicare in it might pour gasoline on the fire, even if the tax increase doesn’t target the elderly. (Indeed, it would largely exempt them, since a high proportion of the elderly are retired, and pensions would be exempt.) Choosing the Medicare tax on investment income instead would likely rile the elderly still further because (as Citizens for Tax Justice notes scrupulously) “people age 65 and older are more likely to have unearned income that would be newly subject to the Medicare tax.” On the other hand, the group observes, elderly people earning more than $250,000 annually, most if not all of it through their investments, aren’t exactly poor.

A wiser course would be simply to adopt the House’s millionaire tax. Senate moderates who sputter about “class warfare” might perhaps be reminded that over the past 30 years this group saw its inflation-adjusted income increase by 226 percent while the share of its income that it paid in taxes fell from 37 percent to 31 percent. If that doesn’t do the job, Reid could promise to maintain the tax on Cadillac health plans, too—for a lot of moderates it’s a badge of seriousness—but if he does so he must the threshold for a lot more professions. Universal health insurance ain’t free.

Update, 8:50 p.m.: The Wall Street Journal reports that the Medicare-tax increase Reid is considering for incomes above $250,000 is not to 2.5 percent, as contemplated by Citizens For Tax Justice, but to 1.75 percent.

Update, 5 p.m.: Jonathan Gruber, the MIT health care economist, informs me by e-mail that I’m wrong to conclude that the treasury will lose revenue under the finance committee’s proposed excise tax on Cadillac plans to the precise extent that insurers keep the value of their health plans under the threshold. I’m wrong “because when employers spend less on health they spend more on wages–and those are taxed.” Such “wage shifting,” Gruber says, was in fact assumed by both the Congressional Budget Office and the Joint Committee on Taxation when they scored the finance bill. The JCT assumed that fully 80 percent of the revenues raised by the excise tax would come not from the excise tax itself but rather from income tax on the dollars that employers divert from health insurance into wages. Gruber has the details here.

I’m glad to hear it. But it remains true that the excise tax raises less than half as much revenue as the House’s millionaire tax.

Correction, Nov. 13, 2009: An earlier version of this column characterized the Medicare tax, erroneously, as regressive. A flat tax cannot be regressive; it is merely not progressive. (Return to the corrected sentence.)